Private equity deals in the government services market are coming fast and are good news for the foundering economy.
Private equity deals in the government services market — four in the past month alone — have been common this year. And, in a bit of good news for the foundering economy, they are likely to remain so, at least until the economy recovers.
It’s the fulfillment of a theory promulgated in “The Role of the Private Equity Sector Promoting Economic Recovery,” a paper by Robert Shapiro, a former economic adviser to President Bill Clinton and former British Prime Minister Tony Blair. The report, published in March, was partly subsidized by the Private Equity Council industry group.
Shapiro starts the report by paraphrasing Homer Simpson’s third response for successful living: “It was like that when I got here." Shapiro begins by saying, "The private equity sector has played no role in the profound problems and dysfunctions that produced the current capital markets crisis.”
The companies that the sector invested in were leveraged an average of 2.2 to 1, he points out. The ratios for those companies invested in by the institutions whose failure did trigger the global economic meltdown ranged as high as 30 to 1.
Further, private equity investments have saved many job, he wrote. Extensive historical data is not available, but “following the last recession, job creation by private equity-held companies appears to have grown nearly 3 percent, while employment across the economy continued to shrink by nearly 1 percent,” Shapiro wrote.
Private equity investments generally parallel those of the capital market at large, although with somewhat greater volatility because of the sector’s comparatively small size.
A little help from private equity investors
So how does that situation help the struggling economy? The data also shows that "private equity investment often continues during recessions and consistently surges during initial recoveries,” Shapiro wrote.
It makes perfect sense, said one industry observer who asked to remain anonymous. Companies can’t get the credit they need in the current economic environment, so they might be willing to sell some assets at a good price as a way of raising needed capital, he said. For example, a company might hold an ancillary business unit that it acquired during a larger acquisition.
Private equity investors might see a business unit that they think is underperforming and that they believe they can steer toward greater profitability. They might think they can enhance the value of a company or business unit.
One course such investment firms might take is to buy an undervalued company, through further investment of capital, management or other resources, and develop the company before selling it at a profit.
Of four private equity fund-backed acquisitions Washington Technology covered in recent weeks, Littlejohn and Co.’s sale of Wyle Holdings Inc., a provider of aerospace and defense information technology and engineering services, to Court Square Capital Partners might be the most traditional. Turnaround buyout firm Littlejohn bought Wyle in 2003 and made substantial investments in the company in 2005 and 2008,
Government technology has been an increasingly active investment area — at least in contrast to the generally near-comatose private sector.
Confirming that trend, the government is steadily spending more on defense, homeland security and intelligence technology. For example, the Office of the Director of National Intelligence recently pegged spending on the National Intelligence Program in fiscal 2008 at $47.5 billion, up 9 percent from the previous year’s $43.5 billion.
“I agree that these investments are a growing trend,” said Josh Lerner, the Jacob H. Schiff Professor of Investment Banking at Harvard Business School. “It is very reminiscent of what we saw during the venture capital downturn, when we saw venture groups investing in national security-related IT companies during the recession of 2001-03."
“In a world where it appears government spending is becoming more and more of an economic driver, it is not surprising that private equity groups are ‘following the money’ and investing more of their capital there,” Lerner said.
An investment platform
One up-and-coming model for making such investments is the government platform company.
When Veritas Capital Fund bought Kroll Inc.’s government services division in June, it had a plan for the acquired company, renamed KeyPoint Government Solutions.
In 2004, the firm bought a major stake in McNeil Technologies, planning to use the provider of language and security services as a platform company. Subsequent acquisitions include Pearson’s government solutions unit, an outsourcing and systems integration provider; DynCorp., which in June won a $915 million, five-year contract from the State Department’s Bureau of Diplomatic Security for protective security for U.S. diplomatic personnel; and CherryRoad GT Inc., which, as CRGT Inc., will focus on security clearance background investigations and employment screening services to U.S. government agencies.
A second private equity firm acquisition in June is the result of a hunting-party variation, in which a private equity investment firm first teams with a knowledgeable executive, and the two seek out a company they can buy and allow the executive to lead.
In March, Robert Coleman stepped down as president and chief operating officer of defense and intelligence agency contractor ManTech International. In April, private equity group GTCR and Coleman formed Six3 Systems Inc. as a government platform. In June, GTCR and Six3 Systems Inc. made their first acquisition: biometric intelligence analysis and forensics provider Harding Security Associates Inc.
Private equity investment firm CoVant Technologies LLC presents another twist on the model: a private equity firm as its own government platform.
In June, CoVant’s first acquired company, A-T Solutions Inc., an anti- and counterterrorism technology provider, made its own first acquisition, of Accelligence LLC, a provider of operations support for intelligence agencies.
As one company, they’ll be able to offer a broad range of services to the national security community, company officials said. But the focus is comparatively narrow for CoVant founder Joseph Kampf.
Kampf helped form defense and intelligence agency IT integrator Anteon International for buyout fund Caxton-Isemanin in 1996. As chief executive officer, Kampf devised a bold, aggressive and successful growth strategy starting in 1997, took the company public in 2002, and sold it to General Dynamics Corp. in 2006 for 23 times Caxton’s original $70 million investment.
“In good and bad times, the core business of private equity funds is to identify firms with long-term potential for higher productivity, sales and profits; secure the capital to purchase these firms; and inject additional capital, improve their strategies and reorganize their operations, to achieve higher returns,” Shapiro wrote.
He concludes that “the evidence and data suggest that the private equity sector can play a constructive and positive role during the current recession and its initial recovery."
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